a. Question Two: Stabilization Policy (this section uses Peter and Hans Jorgen book Chapter 19/21/22 on stabilization po

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A Question Two Stabilization Policy This Section Uses Peter And Hans Jorgen Book Chapter 19 21 22 On Stabilization Po 1 (112.8 KiB) Viewed 11 times

a. Question Two: Stabilization Policy (this section uses Peter and Hans Jorgen book Chapter 19/21/22 on stabilization policy: why and how?) The macroeconomic stabilization policy assumes that it is desirable to stabilize the rate of output and inflation around target values as opposed to fluctuating values. Fluctuating values of inflation and output are sources of instability in the economy. Thus: i. The algebraic expression shows the average welfare loss from a given business cycle as defined in class: TAU θσ; uo? 2 27(1 - a) mPmW Where o and all symbols as defined in class. Explain how the welfare loss is captured by the equation and what should a consumer do to avoid the loss. E[= ] + 1-T ii. Given the following expression: + (a Aš pe + 1) (P – Pe) – (2014-2)) (8 – Pe)? - d Explain how do contribute to consumer welfare loss whenever there are nominal price rigidities in the economy. iii. Given that Ps and P; represent sticky prices and flex prices respectively, while P = Ps, unanticipated inflation is given as TI -7° = (1 - 0) (P;-P) Describe how flex price firms determine unanticipated inflation and further derive the link between unanticipated inflation and consumer welfare. b. Briefly explain why there is time lag in macroeconomic stabilization policy and why such lags reduce the ability of policy makers to stabilize the economy. Discus whether time lag is more serious problem for fiscal than for monetary policy c.